Thomas J. Gordon's  Instablog

      Much has been made of the success of the Apple iTunes App store.  In just 2+ short years since the iPhone has been released in June 2007, more than 100,000 iPhone/iPod Touch apps have been written and released by the iTunes store.    This success has been attributed to many things, the sexiness of the device, entrepreneurial fever, the clever programming features of the iPhone (the iPhone senses how you move the device in your hand and can change the orientation of the screen based on how you hold it).  I would submit that there was a much simpler explanation for the success of iTunes Apps, you could make money selling software again.    When was the last time you saw a successful, new, innovative piece of software you had to pay for on the Wintel or Mac platforms?  When was the last time you paid to use a piece of software on the Web?   The inexorable trend towards Web Pricing removed all the volume platforms (Wintel, Mac, Web) as profitable software platforms for developers with new ideas. 

     Web Pricing is good if you’re a consumer and bad if you’re a software developer.  Web Pricing dictates that you can’t charge for the software itself.   To make money in software now on the Web you have to offer the software for free and make money by advertising or selling add on’s.  Did Facebook charge you to post your latest tidbits on your Wall to your family and friends, not a chance?  Lee Gomes in the Nov16 Forbes stated the definition of Web Pricing very directly: “…. given the manner in which the Internet (the Web) is training most of the world to never pay for anything digital, be it music, newspaper stories, or software.“.  Some of us remember when you used to pay over $400 for a Word Processor with copy protection.  Microsoft, one of the world’s most powerful companies, gets slightly over $100 for MS Office.  In the 1990’s all the software in MS Office would have sold for over $1,000 dollars.    The freeware/shareware movement has built and distributed Database Management Systems (My Sql), browsers (Mozilla ), and communications software (WS FTP) at zero cost to the buyer.  In the past only major corporations with large development staffs would write this kind of software, and they expected to be paid for it.

     So along came the iTunes Apps store which allowed software developers to charge for their creations.  It is an attractive business model for developers who are successful at it.  Apple sells the applications and pays the developer 70% of the proceeds, you don’t even have to worry about Accounts Receivable.   On the surface Apple gives software developers a lot of leeway on pricing, and reversion to Web Pricing seems a long way off.  A person with a musical bent wishing to sell a song on iTunes can only charge 99 cents or a $1.29.  Software Developers are allowed to charge anything from 0 (free) to $999 per download.  Gizmodo’s John Herrman suggests that things may not be as rosy as first appears for iPhone App developers in this article http://gizmodo.com/5378390/the-app-store-effect-are-iphone-apps-headed-for-oblivion?skyline=true&s=i .   He argues there is pressure for iPhone apps to be cheap, even if they provide extensive user value (the App replaces a $200 Garmin) and are priced higher on other platforms. 

     Ask yourself whether an iPhone app is really all that different from a Web app.   The programming involved in an iPhone app is quite different than the programming for a Web app.  That said, I would argue that half or more of the apps for sale on the App store could be programmed as Web apps.  The developers deliberately chose not to write a Web app, even though it would run on more platforms, because they wanted to charge for their application.

     From an investment standpoint there are big players involved in the mobile App space, Apple (aapl)  with it’s partner AT&T (t), and Verizon (vz) and Google(goog) with their new Droid (Android operating system) offering with its Android based App store.  Some in the tech blogsphere claim Apple is pushing for lower App pricing but forget that Apple loses its 30% cut if it drives all apps to be free apps.   So the investment takeaway here is that Apps are not currently a profit center for the major players, and with Web pricing on the horizon, may not be profit centers in the future.    But with Apps known to affect customer loyalty and non-technical corporations (Starbucks, Barnes and Noble, and Target) striving to have an“App Strategy”, the winner of the App war standard may have as much influence going forward as Microsoft did when it established it’s Operating System standard for Wintel PC’s.   Microsoft’s (msft) efforts in the mobile operating system space have not had nearly the success of their Wintel PC offerings.  This may explain  the lack of an App offering with significant market share by Microsoft or one of it’s mobile/phone O.S. partners.

Disclosure:  The author has recently published an App on the iTunes store and is dealing with the vicissitudes of  iTunes pricing and customer expectations around App pricing.  The author is long vz and t, but more as a dividend play than any prediction of who will win the App standards war.  The author is long msft because of their progress in the IT space.  The other companies mentioned in this article (goog, appl) have higher p/e’s than the author is comfortable with.